The cost of clarity

Regulators are determined to increase transparency in Europe's equity markets, in part by enforcing a tighter trade reporting regime as part of MiFID II. But the increased cost of risk trades for institutions could outweigh the proposal's benefits.

What impact could the proposed shortening of trade delays in Europe have on the cost of risk trades?

Quite simply, the cost of capital commitment is likely to increase if trade delays are shortened. This is because brokers will have to factor in the added risk associated with more immediate reporting and pass this on to their buy-side clients.

In its recent MiFID II consultation, the European Commission (EC) proposed a curtailment of the existing deferred reporting regime. This included shortening permitted delays to no longer than the end of the trading day, with trades that currently qualify for a three-hour intraday delay period having to be reported within two hours.

When such changes were mooted in July 2010 by the Committee of European Securities Regulators, the pan-European watchdog now superseded by the European Securities and Markets Authority (ESMA), Credit Suisse released an analysis which showed that for some trades market impact could rocket by 192% if delays were shortened from three days to one.

MiFID allows some large trades to be reported for up to three days, recognising that brokers that take trades on risk require adequate time to unwind positions. But if there is less time to unwind positions, brokers may have to trade more aggressively to complete orders within the allotted time, thereby incurring higher market impact costs, or face the risk of their entire order being made public before completion.

But surely greater transparency is good for the market as a whole?

The EC certainly thinks so. In its consultation paper, it states that a tighter reporting regime would make price formation more efficient and best execution requirements easier to meet.

But industry estimates suggest that trades subject to delayed reporting account for only 1-2% of overall equity trading volumes in Europe, which may make any transparency benefits negligible, while substantially increasing costs for buy-side traders.

Banks also point out that in the UK, reporting delays have existed since before MiFID introduction in 2007, while the rest of Europe had no reporting requirements for trades executed off-exchange.

How has the market responded to the proposals?

Most brokers and buy-side traders have given the plans short shrift.

A recent paper from Deutsche Bank stressed that debate on the pros and cons of reporting delays should not be overshadowed by regulators' concerns over the growth of trading volumes in Europe's dark pools.

The EC's consultation document on MiFID proposes limits on the size of orders allowed to forego pre-trade transparency, to bolster price formation on lit exchanges. But its proposals on trade delays suggest that the commission's focus on market transparency is in danger of being counter-productive, according to Deutsche Bank.

“There is a policy debate to be had because the proposals to reduce the positive impact of the delay regime suggest a misunderstanding of the reason that delays are contentious,” read the Deutsche Bank note.

It added that if trade delays are shortened, ESMA should “keep the impact of the changes under review and recast the regulations if they are found to be inappropriate”.